There's no such thing as a "sure thing" in investing. The closest you'll get, though, is this: When a company announces that it's getting bought out, its shares will very likely rise. That's because the acquiring company typically has to pay a takeover premium to entice existing shareholders to vote for the merger. After all, investors who owned the target company invested to earn a return on their money. For an acquisition to be worth their while, the buyout price has to be high enough to entice them to trade their shares for whatever acquisition currency they're offered.
In fact, look at how some announcements of recent buyout deals affected the target company's stock the next day:
|
Company |
Price Before Announcement |
Price After Announcement |
One-Day Move |
|---|---|---|---|
|
Equity Office Properties |
$44.72 |
$48.14 |
7.7% |
|
Oregon Steel Mills |
$58.96 |
$63.77 |
8.2% |
|
Clear Channel |
$32.35 |
$35.48 |
9.7% |
|
Harrah's Entertainment |
$66.43 |
$75.68 |
13.9% |
|
Kinder Morgan |
$84.41 |
$100.31 |
18.8% |
|
Freescale
Semiconductor |
$30.75 |
$37.06 |
20.5% |
|
OSI Restaurant Partners |
$32.43 |
$39.75 |
22.6% |
Not bad for a single day's return, eh? If only there were a legal way to find out about a buyout the day before it was announced and invest accordingly ...
The next best thing
Unfortunately, if you know of a pending buyout before it becomes public information, it tends to be illegal to act upon that insider knowledge. And unless serving time in a federal penitentiary is your idea of a vacation, don't break the law. What you can do, however, is search the stock market for companies that might be attractive takeover targets and invest with that possibility in mind.
Regardless of the industry, buyouts make sense only if the acquirer can make better use of the company's assets than the market believes the current management can. That's often a pretty tall order, as nobody knows a company as well as its insiders. Yet sometimes a company stumbles enough so that the market throws a legitimate fire sale -- discarding a perfectly good business as if it were yesterday's trash.
When the market knocks down a company's price far enough, it becomes an attractive buyout candidate, even if its fall would otherwise only be temporary. The same discounted price that makes an entire company a bargain also makes it interesting for value investors looking to pick up a few shares. In fact, at Motley Fool Inside Value, we've had more than our fair share of buyouts since our 2004 inception. OSI marks our fourth, following a triple play of MCI, GTech, and Masonite. Those buyouts are part of the reason why we've beaten the market since we started.
Why it works
As individual investors, we'll likely never buy an entire company. Yet we have access to the same public data as those who can do just that. While we may not have their financial wherewithal, we do have a key advantage over the giants -- speed. Virtually nobody has hundreds of millions or billions of dollars of cash lying around waiting to be deployed. Before a buyout can be announced, it needs to be researched and the financing needs to be at least nominally approved.
Most of the time, there are boards of directors, external institutions, and internal controls processes in place that need to be appeased before the offer can be made. While those checks and balances serve to protect investors, they do slow down the process. That gives us -- and you -- the chance to swoop in, buy up a few shares of a dirt-cheap business, and wait for the news.
Of course, not every value-priced company gets bought out. Some recover nicely on their own. And that's the beauty of the approach. Regardless of whether the company you bought gets taken over entirely, the chances are pretty good that you bought your shares at a discount to what they're really worth. If they're taken over, you win quick and big. If not, odds are you'll still do just fine.
Who's next?
Without a working crystal ball or illegal insider information to tell us what the future may bring, we don't know for certain what the next buyout will be. Does that mean you shouldn't look? Nope. Every month, Inside Value uncovers two companies trading at prices that make owning either part or all of them quite attractive. Join us to be among the first to see what the newest bargains are right now. Your free 30-day trial starts here.
At the time of publication, Fool contributor Chuck Saletta owned shares of Kinder Morgan Management, a related company to Kinder Morgan. The Fool has a disclosure policy.
